Make the pain go away

Equity markets in particular are often said to move in the direction that gives the most pain. If the spread betting indexes are good indication of the overall market positioning that's exactly what it is doing now. Spread betters are positioned very much for a closing of the gap between Wall Street and the FTSE 100 that I pointed out the other day. Day traders are very long the FTSE and very short the DJII. This gap will close at some stage, but it shows no signs of doing so at present.

The closer we get to Christmas the more pressure traders will be under from their risk managers to pare back positions. Traders as well as positioning for the gap between London and US markets to close, will also have positioned themselves for the yearend rally that still shows no signs of occurring. With the Fed meeting next week speculation is increasing that the Fed, after the recent economic data, may act sooner rather than later. At this time of year traders will not be encouraged to hold positions over that event.

Most economists and market commentators still express the belief that the Fed could act next week but still expect the Fed to wait until March. I too believed that to be the more likely scenario, but I am now beginning to wonder after the budget agreement yesterday between the Republicans and the Democrats to reduce automatic spending cuts and provide $23 billion in deficit reduction spread over two years, whether the Fed may be more minded to move next week. According to CNBC this deal should mean that US fiscal issues are less likely to be an issue next year, boosting the US economy and removes the possibility of another government shutdown.

Many people expect a negative reaction from equities and bonds when the Fed does announce the tapering of their bond purchases, which may well happen in time. I wonder in the short term if the Fed does act next week, whether markets may take the news better than expected. An announcement by the Fed next week that it is deciding to taper could be the catalyst to the pre Christmas rally. My rational is based purely on the assumption that the Fed will only move when they truly feel the economy is on the path to recovery and investors will take that on board. As I said before most traders by next week will have been forced to close their pre Christmas rally positions, a rally after a Fed taper announcement would again cause the most pain.